How to incorporate or form a LLC

One of the most important reasons to incorporate your business or form an LLC is to protect your personal assets from the claims of your business’ creditors.

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Before you form your company, it is important to know which structure is best for your business. We have compiled the special information section to assist you in making the best decision. Please note, we recommend consulting a lawyer and/or an accounting professional before making any decisions if you are unsure.

puzzle WHICH TYPE OF COMPANY IS BEST FOR YOU?

This is the most common question we receive. As we are neither attorneys nor accountants we cannot and do not offer such advice. We can, however, provide you with some basic information.

We are asked whether the customer should form a corporation and then elect Subchapter S status or whether they should form a LLC. Customers who seek Subchapter S status are looking for a “pass through” entity, an entity that is not itself taxed but passes through its income and expense to its stockholders. Operating a corporation creates its own complications as a corporation must have meetings of its stockholder and meetings of its directors; must keep minutes of such meetings; must maintain bylaws and a stock transfer ledger reflecting its stock ownership. An LLC is a much less formal organization. While the Delaware Act requires that the LLC have a company agreement, it recognizes oral agreements. There are no requirements that the LLC have meetings or keep minutes, though good practice would suggest that the company keep minutes in the event of litigation. For tax purposes a single member LLC is considered a disregarded entity, that is the LLC does not file any tax return and the income and expense of the LLC is reported on the member’s Schedule C. A multi member LLC is a pass through entity, as with a Subchapter S corporation, but without the limitation of Subchapter S; there are no limits on the number of members, members need not be US citizens or pertinent residents, members may be other LLCs or corporations.

If the members of a LLC want to have a Subchapter S entity, the LLC can file Form 8832 with the IRS, and elect corporate tax status and then file a Subchapter S election.

Some customers say that they want to form a corporation as they intend to someday “go public”. If indeed the LLC “goes public” the LLC can, under the Delaware Act convert to a corporation. When it converts to a corporation it remains the same company as the original LLC with the same date of formation and there is no requirement that it wind up its affairs when it converts. All of the assets and liabilities of the LLC remain the property of the converted company with no need to convey or transfer the assets or liabilities.

There is no clear answer to the question, however we can say the Delaware forms many times more LLC than corporations.

Delaware’s General Corporation Law dates back more than a century. Most people understand that a corporation is viewed as an entity separate from its owners, called shareholders or stockholders, and the shareholders are not personally liable for the debts of the corporation unless they have agreed in writing to be liable (responsible) or The term “limited liability” refers to the concept that generally the shareholder’s liability for the debts or obligations of the corporation is limited to the amount of money already paid to the corporation for the stock.

Delaware recognizes three types of corporations: general, professional service and close corporations. Subchapter S is a federal income tax provision (IRC sec. 1361, 1366) which provide that the shareholders recognize the company’s income and expense on their personal tax returns once a timely election form has been filed with the IRS (Form 2553).

General corporation

A General corporation is a for profit business entity which has not made an tax elections, such as Subchapter S or as a Not-For-Profit corporation. A General corporation is the typical business corporation which reports on its state, local and federal tax returns its income and expense and is considered under the tax laws to be a taxpayer separate and apart from its stockholders.

Subchapter S corporation

A subchapter S corporation does not pay taxes itself on its income. Instead, it files an “informational” return on IRS Form 1120S to report the income and expense which the shareholders will report on their personal tax return, Form 1040. There are numerous limitations on subchapter S corporations and their shareholders. When we form a subchapter S corporation we form a “general” corporation and add language to the certificate of incorporation which is intended to protect the subchapter S status from being inadvertently lost once the election form is filed with the IRS. It is your responsibility to timely file IRS Form 2553. We do not prepare or file Form 2553 for you.

Limited Liability Company

The Delaware Limited Liability Company Act is considered to be the most modern and most flexible in the nation. Limited liability companies are a relatively new creation. First legalized in Delaware in 1992, an LLC can be viewed as a partnership whose partners have limited liability. It has all of the best features of partnerships and corporations with none of their rigidity. As with a partnership, the relationship between the partners, and the partners with the company, is determined by an agreement. In an LLC, that agreement is called a company agreement or sometimes an operating agreement. The company agreement may be either written or oral, however, the company  must have a company agreement. If the company agreement is silent on any matter, the  Delaware Limited Liability Company Act  provides the default provisions. We do not think that it is wise to have an oral company agreement, even for a single-member LLC. Delaware Corporate Agents provides forms for preparing your company agreement.

The IRS has ruled that a company that qualifies as an LLC under the laws of its state of formation will be treated as a partnership and its income is not taxed at the entity level. Instead, its income and expense will be taxed to its owners, who are called members in proportion to their ownership in the LLC or as provided in the company agreement. If an LLC has only one member, the IRS still recognizes it as an LLC, however the entity is disregarded for tax purposes and is treated as a sole proprietorship for tax purposes. A single member LLC has the same limited liability as a single shareholder corporation.

The company may be managed by all or just some of its members. If it is managed by less than all of its members, it is considered to be a manager managed company. The person(s) who manage the business is then called the manager. There may be one or more managers, but the manager need not be a member. Managers may be similar to officers and directors, and may have a title such as president. If the company is managed by one or more of its members (but less than all), that person is sometimes called the “managing member.” The LLC tax report is not required to be signed by the LLC.

puzzle WHAT IS THE DIFFERENCE BETWEEN CORPORATIONS VS. LLCs

limited liability company act + tax consideration

The Delaware Limited Liability Company Act is considered to be the most modern and most flexible in the nation. Delaware places almost no limitation on the ingenuity of attorneys and business persons in drafting company agreements. In fact, there is no requirement that either a shareholder of a corporation or the member of an LLC be an US citizen or resident. The same applies to officers, directors and managers.

Unlike a subchapter S corporation, an LLC is not subject to rigid tax laws regulating who may be a shareholder, the nature of the business, the number of shareholders or any requirement that tax election forms must be filed with the IRS.

Please remember that an S corporation must pay FICA taxes on wages paid, including wages paid to shareholders, but not on earnings and profits (dividends) distributed to shareholders. Members of an LLC, except those who do not participate in the management of a company with centralized management, must pay self employment taxes on income derived from the LLC.

Delaware requires that corporations report only the names and addresses of its officers and directors on an annual basis. The names of shareholders are not filed with the State of Delaware. Delaware does not require the names of either members or managers of a LLC to be filed with the state, likewise the LLC agreement or Operating Agreement is a private document which is not filed with the state.

Please remember that this article is not intended as a substitute for good legal or accounting advice.

The Delaware Limited Liability Company Act is considered to be the most modern and most flexible in the nation.

David Doe

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